Recent US Bank Failures: Impact On The Indian Stock Market

Two U.S. banks, Silicon Valley Bank (SVB) and Signature Bank, were ordered to cease normal operations this week because their liabilities far exceeded their assets.

Causes of bank failures

Different causes led to the failure of these two banks. The Signature Bank's massive crypto-currency investments resulted in enormous losses, which eroded its capital. Efforts to re-capitalize the bank were unsuccessful, and the US banking regulator ordered it to cease normal banking operations.

At end-Dec'22, the SVB was a mid-sized regional bank in the United States with assets of just over $210 billion. Most of its deposits came from technology start-ups, and most funding by the bank was also directed toward technology start-ups.

In tandem with the sharp increase in profitability and funding of the technology sector between 2020 and 2022, SVB nearly tripled its deposit base. Its financial health began to deteriorate in the course of 2022, when the technology industry began to experience declining profits and diminished access to capital. A large part of the SVB's assets consisted of government bonds and mortgage-backed securities. Compared to the average U.S. bank, which holds approximately 20% of its total assets in securities, SVB held close to 60%.

Since 2021, when US bond yields began to rise sharply, unrealized marked-to-market losses on the bank's security portfolio began to accumulate.

Due to rumours of financial difficulties at SVB, depositors attempted to withdraw $42 billion. To meet this demand, the bank had to sell securities, which resulted in the realization of previously unrealized losses and eroded its capital base. As the bank's attempts to raise capital failed, US banking sector regulators demanded that it cease normal banking operations.

Actions taken by U.S. authorities

It has been communicated that there are no plans to rescue these two banks with public funds. Therefore, equity holders and unsecured lenders to these banks must bear the entire market-related fall in the value of their assets. All bank depositors, regardless of whether they have insured or uninsured deposits, have full access to their accounts at all times (now being run under the receivership of the FDIC). Any costs incurred to repay depositors over the banks' assets would be borne by the FDIC (the deposit insurance authority in the US).

To meet the liquidity needs of US banks, the authorities have established a funding mechanism allowing banks to borrow from the Federal Reserve against the collateral of government securities and mortgage-backed securities at face value (i.e., without any marked-to-market losses) for the next one year.

Impact on the Indian stock market:

Regulation, supervision and accounting requirements for Indian banks are significantly more stringent than those for American banks. Unlike in the United States, Indian banks must make provision for all unrealized marked-to-market losses outside their held-to-maturity (HTM) portfolios. Most private sector banks in India have a relatively small HTM portfolio. Therefore, the shock experienced by SVB is unlikely to occur in India.

With the Federal Reserve injecting liquidity and adopting a more dovish monetary policy stance, it is probable that the Reserve Bank of India will adopt a similar strategy. Therefore, the outlook for the country's interest rate environment is more optimistic than previously.

The failure of two U.S. banks has no material effect on the earnings outlook of Indian publicly traded companies.

Besides, the anticipated decline in interest rates, including bond yields, would reduce the discounting rate on future earnings of companies, which would have a positive effect on the valuation of Indian equities over the medium to long term.

Conclusions:

The two recent bank failures in the United States have no material impact on the earnings of India's publicly traded companies. As a result of the incidents, the outlook for interest rates improves. This could increase the price-to-earnings multiples used to value Indian equities. We continue to believe that the Indian equity markets will generate returns of approximately 12%.

(Taken from the broking report of Anand Rathi)